Reserve weighs up high dollar on rates

The Reserve Bank will place greater emphasis on the suffocating impact the high Australian dollar is having on the economy when it meets for the first time this year to consider interest rate cuts, although expectations are building the central bank will hold off on further cuts until March.

Even with softer economic data adding further pressure on the RBA to lower interest rates, market forecasts of a February cut have fallen to their lowest level in months.

Financial markets' pricing of an interest rate cut in February stood at 22 per cent, Credit Suisse data showed. Markets were still pricing in a likely cut in the cash rate by 25 basis points for the year, and a 50 per cent chance of a second rate cut.

The release on Friday of weaker-than-expected Chinese official purchasing managers' index (PMI) data pushed the Australian dollar to a low of 103.8¢ against its US counterpart, but some economists said they expected the dollar to remain at $1.04 to $1.05 for the year. This high dollar, they argue, could force the RBA to continue its easing cycle, although from March rather than in February.

"We think it is going to be like a war of attrition, with the currency staying high and the RBA being very careful," the National Australia Bank's chief economist for markets, Rob Henderson, said.

"We don't think they are going to rush in and do two rate cuts in a row. But we think the evidence will keep accumulating, with the economy still soft, unemployment rising and the inflation outlook continuing to be better,'' he said.

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NAB expects the Reserve Bank to slash the cash rate to 2.25 per cent by the end of 2013, with an average of about one cut per quarter. Currently the cash rate is 3 per cent.

Justin Fabo, the head of Australian economics at ANZ, which tipped a cash rate of 2 per cent by the year's end, said higher unemployment and subdued corporate capital expenditure plans could be factors in pushing the RBA to act in March.

The Australian dollar's strength would also continue to dampen investment outside mining, stifling growth in sectors such as tourism and agriculture, Mr Henderson said.

"This high currency is causing a lot of problems across the economy, and we think that means growth in our economy over the first half of the year is going to be very weak," he said.

Michael Workman, a senior economist at the Commonwealth Bank, which along with HSBC expects rates to remain at 3 per cent for the year, said there had been a shift in the risks - especially offshore - to the Australian economy.

"The US and the European data is implying an improvement in their economies … while it's quite obvious that China's growth bottomed out around about the third quarter last year and is also improving," Mr Workman said.

HSBC chief economist Paul Bloxham said he believed the "soft patch" in the Australian economy had passed. "The weekly consumer sentiment measure has risen sharply and daily housing price data showed a pick-up in January. Business sentiment bounced back in December and new home sales have risen solidly. Equity prices have rallied recently, hitting a 20-month high," Mr Bloxham said.

On Friday, the run of positive data from China hit a bump when the January PMI slid to 50.4 - below expectations - from 50.6 in December.